Constructing Oil, Gas Lease Agreement

Tips for constructing an oil or gas lease agreement

You’ve heard the gossip at the grocery store. You’ve seen the headlines in your local newspaper. The oil and gas companies are coming to town. Signing up for a lease seems like an easy way to boost your bottom line, but at what cost to you and the future of your farm? Here are some things to think about before you sign on the dotted line.

Education. Before signing a lease, take some time to visit a couple of well sites for a visual perspective of their size and scope, encourages Eric Johnson, an attorney and partner with Johnson & Johnson Law Offices, based in Canfield, Ohio.

"You need to have a picture in your mind of what these sites look like and how big they are," Johnson contends.

He says farmers can expect, in a best-case scenario, a minimum of 10 acres to be taken out of commission if a well is placed on their property.

To boost their knowledge about the oil and natural gas industry, Johnson also advises farmers to go online to read articles and check out other land owners’ experiences on YouTube.

Know the language. "Probably the biggest mistake I see is not understanding the lease," notes attorney Ronald Coyer of S.R. Law in Slippery Rock, Pa.

"I always try to go through an education process with clients and walk them through the entire lease line by line," Coyer says. "Here’s what the lease means, and here’s how it affects what you’re doing—because it can have some effects."

Coyer says to carefully review any protective terms. Ask yourself: What rights does the oil or gas company have? What can you as a landowner do? How does this affect my land? How does it affect the resale value? Can I keep the oil and gas rights if I decide to sell the land?

Cost and no-cost leases can be particularly confusing to muddle through. A cost lease means the oil or gas company can charge you a certain percentage on your royalties for production costs.

"A lot of these leases are written in a manner that if you’re not used to understanding and reading them, you could read it and believe they can’t charge you anything," Coyer says.

He says another item to watch for is the Pugh Clause, which states that once a land lease’s primary term expires, the oil or gas company must release any acreage that isn’t in production.

"All of these companies look to the effect of, how do we hold onto this piece of property without really doing something because we want to maybe keep it in our bank of assets and pull it out when we need it," Coyer says.

For example, if you sign a lease with no drilling depth provisions, the company can drill a shallow well, keep it in production cheaply for as long as it wants, and later go in and deep-drill.

"That upsets landowners," Coyer says. "We see a number of those every week. We’re seeing them a little less now because people are becoming more educated."

Basically, Coyer says, you need to know what addendums (or amendments) are and how they work. You can add addendums to a contract that overrule what the original contract states. This is where you can build in many protections and provisions.

Know when to sign. How do you get the best price and protective terms? "Obviously, you want to sit down with a lawyer who has experience with this process and have him review the lease," Johnson says.

His typical service charge is $500, a small investment that could provide thousands of dollars in return. "A lawyer knowledgeable about these types of leases should be able to provide some good guidance on the financial terms, and even help make sure you don’t leave money on the table," Johnson notes.

Coyer says that timing and location are pivotal to getting the most bang for the buck with land leases.

"People have to understand that it’s about location and probably a bigger aspect, timing, in that market," Coyer explains. "It’s like anything else. If there’s no demand for something, the price goes down. If there are multiple players and a high demand, the price keeps moving."

When oil or gas is first discovered in an area, companies work the area to lease as much land as they can, regardless of whether they will actually drill there—what Coyer calls a "land grab arrangement." As more and more land is leased under these blanket arrangements, eventually competition between companies starts to dwindle, and the major players emerge depending on who leased the most land. The land grab subsequently slows, and those major companies start building and developing their drilling units.

"People often ask me, ‘When’s the right time?’" Coyer says. "It’s hard to know, but when we get toward the end of the blanket lease arrangement period, before they start unit leasing, that’s probably the time when you can convince an oil and gas company to give you the best protective terms with the most addendums and probably the highest value.

"It’s just like anything else. The more entities that are trying to get the same thing, the prices escalate; when they get closer to drilling, the prices and terms, along with the protections that go with it, start being pulled back off the table."

In a best-case scenario, experts say farmers can expect a minimum of 10 acres to be taken out of commission when a well is established on their property. That’s important to factor into the overall ROI equation.

Don’t be intimidated. While there are many horror stories of landowners being railroaded by a company or blindsided by terms in their lease, Coyer says that most reputable oil and gas companies are willing to work with the landowner to come to a mutually beneficial agreement.

"Most of the land agencies that are coming in now are saying, ‘This is what we’d like to do. What else can we do for you to make this work?’" he says.

Johnson agrees with Coyer’s assessment. "Most of these companies are staffed by good, hard-working people,"

Johnson says. "A minority may try to cut corners, but most of them don’t want their reputations sullied—that’s not in their best interest."

Coyer adds that many companies are willing to help landowners make improvements to roadways or farmland, and do their best to keep the land in good condition. However, he also cautions that there are some companies who still conduct poor business, trying to strong-arm the landowners who sign leases with them.

For more information on the issues and faces behind the energy explosion in rural America, including photos and videos, visit www.FarmJournal.com/energy_boom